We all work to make money. And then comes in the taxman to take his cut. Salaries in the UK are taxed up to 45% and that excludes National Insurance one has to pay. There is more to this though that many don’t realise – stealth tax.
Stealth taxes are something that often bites – yet not many realise it straight away. This does however reduce publics buying power.
Below I will explain what stealth taxes are. I will also give a couple of examples of what the recent stealth taxes have been applied to people in the UK.
what is a stealth tax
When government needs money – they are looking into how to make more through the taxation system. And this is normally achieved in one of the 2 ways – a tax that you know off or a stealth tax.
Examples of taxes that you are aware off are the likes of income tax, VAT, council tax and so on. These taxes are publicly known and you can easily find information on these. It is also easy to calculate – how much these taxes cost you.
Stealth taxes on the other hand are hard to spot. Government often doesn’t advertise how much these are changing and how this will impact people.
Stealth taxes on individuals can be done in several ways and I will review these below. The main ones that come to mind – are passing taxes through businesses, reducing the buying power of pensioners or reducing/freezing certain benefits.
If all 3 of the above are applied at the same time – this can have a sizeable impact to an individual.
passing taxes through companies
Firstly, I will review how the government passes taxes onto individuals through businesses. This is something that can happen fairly easily.
Normally businesses operate to a certain profit requirements in order to stay afloat. If the government increases tax on a business – this has to be passed onto the consumer either through product weight reduction or price increase.
Profit squeeze can often lead to consumers being passed on a way bigger price increase or weight reduction than the company had to deal with in the first place. This is a way the company can actually expand its profit margin.
These types of stealth taxes can often lead to inflation caused by the government looking to make more income through the tax.
freezing or reducing benefits
Next way the government can pass on stealth taxes – freezing or reducing certain benefits. An example can be tax free income. This is also called your personal allowance.
Personal allowance currently stands at £12,570. This mean that the first £12,570 of your income are tax free and 100% yours to keep. As you can see in the image below – this has been increasing up to 2020. The councillor has however announced a freeze to this value for years to come.
You might ask – how is getting free income linked to a stealth tax. The answer is simple – inflation. Inflation makes the same items you buy today – more expensive tomorrow.
Let’s imagine that the inflation stands at 5%. This means – a basket of services and goods that cost you £10,000 today will cost £10,500 in a years time. This is an increase of exactly 5%.
In order for you to be able to afford everything you were able to afford before, your income needs to go up by 5%. Let’s imagine your salary is £20,000 and you pay 20% tax on all the income above your personal allowance (£12,570).
You currently would have to pay 20% tax on £7,430 – the tax would be £1,486. This would would leave you with a net income of £18,514.
Next year you can proudly say that you got a 5% pay rise that brings your income to £21,000. And again – you need to pay 20% tax on all income above your personal allowance. Your taxable income would be £8,430. The tax you would pay be equal to £1,686.
This would leave you with net income of £19,314. What this means – that your actual net salary increase is only 4.3%. The stealth tax hits you in the form of taxman due to personal allowance freeze.
pensions and stealth tax
Similar concept to the one can be applied to pensions. This however can be executed in multiple ways.
Firstly, the government can silently reduce the threshold at which pensionaries need to start paying tax on their saving. This will obviously reduce the amount that one has in their bank account each month.
The alternative way the government can go about reducing the buying power of people who have retired – increase their pension by less than the level of inflation. This would mean that with each year a retired person would be able to afford less and less services and goods.
This is where the pension triple lock is becoming vital in order to preserve pensioner buying power.
summary
I am fairly confident in saying that the government will keep looking for ways to increase the income they make from taxes. What this means – both taxes you can easily see and the stealth ones will keep increasing.
There are many ways in which the government can reduce your disposable income. Looking after your own interests is a great way to avoid being in the situation where you annual expenses have to reduce.
Investing early in your life can help significantly. If you do so through an ISA – that is tax free income for you for life. No visible or stealth taxes can dent your income there.